"Completing the Accounting Cycle", Part II

Financial Statements and GAAP Principles

GAAP Conventions

• Comparability and Consistency

  • Financial statements should allow users to identify similarities, differences, and trends over time and between companies.
  • Consistency in accounting principles is essential for comparability.
  • Example: Using the same depreciation method consistently.

• Materiality

  • Relates to the significance of an item to the business.
  • Must follow GAAP standards for material items.
  • Levels of materiality vary.
  • Example 1: $100 difference in a $1,000 cash account is material.
  • Example 2: $500 error in $1,000,000 revenue is not material.

• Cost Benefit

  • The benefits of providing accounting information should outweigh the costs.
  • Benefits > Costs.

• Full Disclosure

  • All relevant information about the business must be disclosed.
  • If the cost of including information on the financial statements outweighs the benefits, it should be included in the notes to the financial statements.

• Conservatism

  • Choose the method that is least likely to overstate assets and net income when faced with uncertainty.
  • When in doubt, be conservative.

Classified Balance Sheet

Purpose

• Provides a more understandable format for users.
• Aids in assessing liquidity and profitability.

Components

• Assets: Resources.
• Liabilities: Obligations.
• Owner's Equity: Claims.
• Classified balance sheets categorize assets, liabilities, and owner's equity into subgroups, unlike unclassified balance sheets.

Asset Categories

• Current Assets

  • Most liquid assets.

• Long-Term Investments (Long-Term Assets)

• Property, Plant, and Equipment (PPE)

• Intangibles

Liabilities and Owner's Equity Categories

• Current Liabilities

• Liabilities

• Owner's Equity

  • Partnerships: Multiple capital accounts (one for each partner).
  • Corporations: Shareholders' or Stockholders' Equity.

Current assets

• An asset is current if it will be converted into cash or used up within one year or the operating cycle, whichever is longer.
• Operating Cycle: The time it takes to generate revenue and collect accounts receivable.
• Assets listed in order of liquidity.
• Cash and cash equivalents are considered equivalent to cash.

Long-Term Investments

• Assets that will be converted into cash or used up after one year or the operating cycle.
• Assets not currently used in operations.
• Example: Land held for future use.

Property, Plant, and Equipment (PPE)

• Tangible assets (physical substance).
• Depreciated assets.
• Historical cost rule applies.
• Except for land, all PPE assets have an accumulated depreciation account (contra-asset).
• The matching rule is applied when allocating the cost of the asset over its useful life.

Intangibles

• Assets without physical substance (rights).
• Currently used in operations.
• Expensed through amortization expense.

Liabilities

• Current Liabilities: Obligations to be paid within one year or the operating cycle.
• Long-Term Liabilities: Obligations to be paid after one year or the operating cycle.
• Current liabilities are paid off our current assets
• Long term liabilities are paid off our long term assets

Stockholder's Equity

• Sole Proprietorship: One capital account.
• Partnerships: Separate capital account for each partner.
• Corporations: Common stock and retained earnings.